Stock prices more sensitive to sales growth than profits

Mumbai, March 22 | Updated: Mar 23 2005, 06:13am hrs

Stock markets have always given a premium to fast growing companies in terms of income. In a simple statistical regression calculation, it will not come as a surprise that stock prices are more sensitive to sales growth than to profit growth. The dependency factor of stock prices to sales works out to 5.56% as compared to 0.10% for net profits.

In the last six months, a lot of companies managed to show an increase in stock prices despite a fall in profit growth. This was especially true in banking stocks. An analysis of the A group stock shows that out of the 199 stocks, there were 52 stocks whose sales growth was up and profit growth was down and out of these 52 stocks, 41 stocks (of which 10 belonged to the banking industry) had given positive returns. The average return of these stocks is 30% in the last six months. In the case of rest of the companies, the average income growth was 25% against a profit growth 65% and stock price on an average were up by 30%.

The overall average shows that sales went up by 30% and profits by 68%. If one look at only those companies where sales are growing up and profits are falling, one will notice that the average return on stocks is much higher. Take, for example, the banking sector.

For the banking industry, where the banks that have shown income growth of 15% and profits have dropped by 66%, stock prices have gone up by 52%. Market analysts attribute this to the flavour that the market is catering at that point of time. In spite of banks posting huge losses on account of falling treasury incomes, the stocks are favoured by analysts on the basis that banks are back to their basic activity of lending.

Says AK Sridhar, chief investment officer, UTI, The market is looking at volumes and sales drive volumes. In terms of banks, this can be seen in income growth. Banks showing higher income growth shows that disbursement is taking place and credit is improving.

A similarity can be observed in the software sector as well. In a sample where sales growth is positive and profit growth is negative, sales for the software sector has grown by 40% and profits have fallen down by 30% and stocks prices on an average have gone up by 17%. Ramco, D-Link and HCL Technologies are some of the companies that have shown a surge in stock prices inspite of fall in profit growth.